ECB to set out its plan for monetary policy normalisation

Chris Scicluna

Ahead of the ECB, Asian stocks softer despite better Chinese trade data
Ahead of this lunchtime’s key ECB policy announcements, when the Governing Council will announce its plans for policy normalisation (see below), euro govvies are little changed this morning after yesterday’s further weakness (10Y Bund yields now just above 1.35%) as are USTs (10Y yields around 3.03%). But Asian stocks largely fell back today (the Hang Seng is currently down about 1%, although the Topix closed little changed), while US and European stock futures are weaker too. Stronger-than-expected Chinese export data (more on this below too) failed to counter unease about the ongoing uptrend in crude oil prices (Brent briefly rose above $124 per barrel overnight) or indeed reports of a plan to lockdown one Shanghai district for Covid testing on Saturday morning. And an explosion in a Texas LNG export facility that will likely hit shipments of natural gas to Europe will only add to inflationary concerns in the euro area.

Key points to watch as the ECB sets out plan for policy normalisation
All eyes at lunchtime on the ECB as it sets out its plan for monetary policy normalisation. An unambiguous signal that successive rate rises from July onwards are on the cards seems highly likely. But the size of the first hike will be left open. In addition, a decision to end net asset purchases this month is also highly likely, even while the establishment of a new instrument to address fragmentation risks might also be endorsed. The key points to watch are as follows:

1. What’s the timetable for rate hikes?
While the odd hawk on the Governing Council might argue for a rate hike today, an unambiguous announcement of lift-off at the 21 July policy meeting and further hike at the following meeting on 8 September, allowing it to exit negative rates by end-Q3, appears most likely. We also expect the Governing Council to signal that, subject to the incoming data, it expects to keep increasing rates thereafter until they are eventually back into (unspecified) neutral territory, likely in practice to be somewhere between 1-2%.

2. Rate hikes of 25bps or 50bps apiece?
Despite the current preference of the Fed, BoC and RBA for hikes of 50bps, when the time comes we still expect the ECB’s deposit rate to be hiked in increments of 25bps per meeting. That pace has been described by Chief Economist Lane as the benchmark while another member of the Governing Council suggested last week that there would likely be no “general support for a 50bps hike”. But Christine Lagarde today seems likely to leave the door open to hikes of 50bps apiece if the incoming data demand them, and there will be several Governing Council members in favour of such moves. And confirmation of the end of the special interest rate on the TLTRO-III loans from 23 June will imply an increase of 50bps from that date on the cost of that longer-term liquidity.

3. An immediate end to QE?
According to its current forward guidance, the Governing Council still expects to conduct a further €20bn of net asset purchases this month before ending them in the third quarter. But given the big leap in inflation to 8.1%Y/Y in May, that seems undesirable and the announcement of an immediate end to those purchases today might now seem appropriate.

4. Will ECB confirm a new policy tool to counter fragmentation risks?
While net purchases under the APP will come to an end, most Governing Council members seem ready to support a new policy instrument that could be used to support certain stressed sovereign bond markets (most obviously BTPs) if and when fragmentation risks emerge as rates are hiked steadily higher. Whether the ECB announces any substance today remains to be seen. And the mechanics of any new instrument are clearly open to debate. This week the FT reported that, in certain circumstance, reinvestments of maturing proceeds of PEPP bonds might be brought forward ahead of schedule and redirected to stressed markets. If so, the monetary impact of such purchases would likely be sterilised to avoid accusations of a restart to QE. The nature of any conditionality attached to the use of any new instrument will also be contentious – indeed, the hawks will argue that a new instrument is unnecessary given the existence of the Outright Monetary Transactions (OMTs), which are conditional on the existence of an ESM programme.

5. How gloomy is the euro area economic outlook?
The Governing Council’s decisions on policy will be guided by its updated projections, which will revise up sharply the expected profile of inflation from the ECB’s previous baseline published in March. The new inflation forecast will more closely resemble its previous “severe” scenario of an average of 7.1% this year and 2.7% in 2023 than its baseline of 5.1% and 2.1%. But the ECB will still expect inflation to return back to the 2% target over the medium term. While the risks will be two-sided, the skew is likely to be very much to the upside given the possibility of disruption to energy supply as well as hints of a recent shift in firms’ pricing behaviour. Despite stronger-than-anticipated euro area GDP in Q1, we expect the ECB’s forecast for growth to be revised down from the current baseline of 3.7% in 2022 and 2.8% in 2023.

China exports beat expectations sending trade surplus to four-month high
While the news on Shanghai lockdowns today was disappointing – with one district to be closed on Saturday morning to conduct mass testing – the easing of restrictions last month meant that China’s exports were able to rebound and at a stronger pace than anticipated. The value of exports in USD terms rose 16.9%Y/Y up from 3.9%Y/Y the prior month and more than double the median forecast on the Bloomberg survey. On the same basis, imports were also a touch firmer, up 4.1%Y/Y having been unchanged in April from a year earlier and compared to the BBG consensus of 2.8%Y/Y. As such, the goods trade surplus rose more than $27bn to a four-month high of $78.8bn, alleviating some downwards pressure on the offshore yuan that has been accentuated by the steady downtrend in the yen. With major central banks pressing hard on the brakes, however, question marks about the resilience of demand for Chinese exports over coming quarters are hardly going to disappear.

UK housing survey signals slight easing in demand and weaker outlook
The RICS residential market survey for May signalled a slight softening in new demand for properties and a broadly flat trend for sales. And sentiment with respect to sales twelve months ahead was also weaker in the face of various headwinds such as falling real pay and rising interest rates. Nevertheless, home prices, which were up 11.2%Y/Y on the Nationwide index last month, are still predicted to keep rising, albeit at a more moderate pace than of late. In particular, the net balance for new buyer enquiries fell 15ppts to -7%, the first negative reading in nine months. The equivalent index for near-term sales expectations dropped 9ppts to 1%, but the longer-term expectations balance for activity fell 20ppts to -24%, the weakest since October 2020. Given still tight supply, a net 73% of those surveyed – down 7ppts from April but close to the average of the past six months – reported an increase in house prices last month. But the net balance regarding the price rises in twelve months’ time dropped 36ppts to +42%, still pointing upwards albeit by the least since January 2021.

US focus on jobless claims and the flow of funds
Another quiet day for US economic data will bring the latest weekly jobless claims figures as well as the Fed’s flow-of-funds figures for Q1. The latter will take stock – among other things – of the state of household balance sheets.

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